Many contractors can build better cash flow using accounting options that until passage of the Tax Cuts and Jobs Act (TCJA) were unavailable to them. Nevertheless, there remains a surprising number of construction companies that don’t know if the TCJA provisions lay the foundation for better financial positioning.
Prior to the TCJA’s passage, under IRS rules, C corporation construction companies or companies that had a partnership with a C corporation weren’t able to use the cash accounting method if their average gross receipts over a three-year period were between $5 million and $25 million. Not only that, but a small business couldn’t use the cash method if its gross receipts were greater than $25 million in any year, not just the preceding three years.
Small contractors were limited to the percentage of completion or accrual methods of accounting. These differ from the cash method in that income is recognized when the contractor receives payment for services. Expenses are deducted at the time the contractor makes a payment for supplies, materials – anything that falls under the tax code heading.
Before the TCJA changes, contractors with average gross receipts of up to $10 million had to use either the percentage of completion or accrual accounting methods. Percentage of completion is determined by how much of a project is completed during the tax year. Under the accrual method, revenue recognition and expenses aren’t tied to when they’re received or paid. For example, the contractor recognizes revenue when the project owner is billed, not when the cash is in hand. Expenses are paid when incurred, which can make cash flow an issue.
The TCJA broadened the cash-method universe to include companies within the $5 million to $25 million limits. Normally, the faster a company’s revenue is recognized, the sooner it owes taxes. Generally speaking, if a company’s accounts receivable are higher than its accounts payable, the cash method offers an opportunity to defer income on which, using other accounting methods, taxes would be higher. It doesn’t mean taxes go away, but deferral delays paying taxes and enables contractors to increase near-term cash flow and use funds for business needs, or anything else, that would otherwise go to the federal government sooner rather than later.
Why might a contractor not already have taken advantage of this option, or even have explored it in-depth? Among the reasons is, “But we’ve never done it that way, we’ve always done it this way.” Another approach is that it’s easier to do what’s always been done than try something new. Fear of the perceived (or actual) complexities of taking on a new system is sometimes cited for not venturing into this previously unexplored territory.
Under any accounting system there are timing factors and nuances of IRS rules that guide and direct – or confuse and obscure - when revenue is recognized and when taxes must be paid.
The cash method can simplify decision making for many contractors. This is not to say that the cash method is always the correct one, all the time, for contractors within the gross receipts limits. Given the TCJA’s effect on construction companies, now is always a good time for contractors to sit down with construction accounting experts to chart the best accounting method direction to construct the company’s financial pathway.
This article first appeared in KnoxNews.
